Emmanuel Daniel (ED): I’m speaking today with Sir George Mathewson, the man who is credited with building RBS into the behemoth that it became in the 1990s, and was chairman until very recently in 2006. We want to know from Sir George what he learnt as he built his franchise—and now, when he looks back on all that has happened with RBS and the UK banking system, what he thinks should have been or could have been done. Thank you very much, Sir George, for speaking with us today.

Sir George Mathewson (GM): Thank you, Emmanuel.

ED: In the time that you were CEO of Royal Bank of Scotland, and then as you built it the way that you did, what’s different in terms of building an organic business in the 1990s compared to what you think it would take to build a commercial bank to the size of RBS in the time that you were CEO?

GM: I suppose the biggest difference is in the macroeconomic situation in Europe as compared to what it was then. I mean, I was lucky in as much as we had a ten-year run or so of uninterrupted economic growth; I inherited a bank that was in very poor condition, but had the time and the capital to fix that and then benefit from the economic growth in the following years. I think today’s situation in Europe is very different from that, and I think that the managers of today’s large banks in the UK face a challenging position with the economics and, of course, the changes in bank regulation and capital requirements.

ED: You inherited a bank that was essentially in a very weak position. I think the NPLs were very high, and the UK itself was coming out of a very bad recession. What were your priorities at the time that you took over as CEO, and what did you focus on in the initial years?

GM: Well, my major priority was to restructure and divisionalise the bank. I felt that the geographical way in which the bank was divided was old-fashioned and did not fit the bill at all. Even though it was a standard approach of European banks at that time, the most important thing was to get the right people in the right jobs. Divisionalisation is one thing, restructuring is another, but you’ve got to back it up by putting the people in the jobs that really believed in what we were doing and had the ability and energy to put it into practice.

ED: And how much time did that take? Two years? Four years?

GM: To complete it took three years or so. But in actual fact, we made very rapid steps from day one, and very fast actions in terms of immediately formally restructuring the bank, immediately making key appointments and immediately reducing the head count in areas where it could be reduced.

ED: And then there comes a point where you started being bold—the acquisition of National Westminster, for example, which was a much bigger institution than RBS was at that point in time. Had you come to a point where you needed to switch techniques or become more aggressive?

GM: I think by that point, we had proven ourselves that we could run the bank. We had some of the best performance figures in the UK. We were generally approved of by investors and by observers as running a very good institution, which originated many new ideas and new businesses. So we had the confidence of investors. We also, of course, got to the point where we had to ask “where do you go?” And the obvious thing was acquisition. However, the only banks that were under-performing in the UK at that point in time were Barclays and NatWest. And it was felt that Barclays was not really available and NatWest was doing very badly, and we knew that there wasn’t any shareholder loyalty in that case. So we saw that as an opportunity.

ED: You mentioned that the macroeconomic environment is important. You grew the bank on the back of a recovery in the UK, and today banking as a percentage of GDP in the UK has become quite large. How large should a bank grow relative to its domestic market? To what extent should regulators liberalise the environment so that banking becomes a strong pillar of the economy?

GM: Well, as to the percentage of the GDP, I’m not sure I can answer that. And the UK is in a special position with regard to London, the City of London, its geographic position and various other things. There are four or five very large banks still in the UK. So I believe that it wasn’t actually the magnitude of the financial sector that was the problem in the UK; I know this is talked about because of the downturn in it and the effect that’s had on the whole country.

So you are saying that if a financial set gets beyond a certain size, then the national—there is a risk at national level—and I think that’s a matter for the regulators to look at. I’m not sure of what the correct answer to that is.

ED: What changed at RBS after you left?

GM: Well, of course, I wasn’t there after I left so I’m not sure I can fully comment on that. What I would say is that investment banking started to play a bigger role. It had already started to play a role before I left RBS; I personally have never been an enthusiast of investment banking, because I don’t believe the culture fits easily with a commercial bank. I don’t believe that a remuneration culture fits well with the concept of achieving a long-term committed organisation. It breeds a degree of individuality in terms of rewards, which is not helpful. So that definitely changed.

I do believe that, with securitisation and syndication assuming a bigger and bigger role all the time, there would appear to be a decline in credit standards. Now, I cannot say for certain that that’s the case, but from what’s emerged since, we could deduce that there does appear to have been a decline in credit standard.

ED: But isn’t that the pressure that is put on any institution that succeeds to a certain level—and then the next level is really getting as much of the assets off the books, maximising shareholder return and then getting into businesses so that you can scale even further? Didn’t RBS do what it logically would have done, given the opportunities that were in front of it after it grew to a certain size?

GM: Yes, there’s truth in that. You’re also looking at the shareholders’ and the investors’ drive to increase profits, to increase returns, and perhaps in the light of macroeconomic fundamentals, we look back and we feel that that should have been moderated somewhat. So I think it’s easy in retrospect, but I know when you’re there and there’s the shareholders and the press, etc. wanting more profits, it is hard to throttle back the animal.

ED: You’ve said that you’re not a fan of investment banking …

GM: I’m not a fan of it together with commercial banking.

ED: To what extent is a bank’s propensity to go into investment banking a result of the personalities put in place to grow the business and also the pressure put on an institution to make investment banking part of its core business? HSBC, for example, has had this pressure on it as a global bank for a long time, and almost anything it does is measured to how good it looks relative to a global investment bank.

GM: I think that’s a problem. I do. I think that the way that investment banking rewards put people and institution is short-term. It’s immediate and it tends to lead to good results as far as the individuals are concerned, but it does not necessarily lead to long-term value creation for the institution, and in my view it can damage the human relation side of the institution.

ED: But how long do you think banking as a business can hold out given the fact that there is pressure from investors? There’s also pressure from what we call today the shadow banking industry—the hedge funds that are declaring far more profits, pulling a lot more talent, than commercial banks. And there’s always a temptation for a CEO to look across the fence and say, “Why can’t we bring this on in-house and make the business a lot more profitable?”

GM: Well, yes, except you’re taking on more risk. I mean, the record is not great, is it, in terms of what investment banking has done for commercial banks? I think it is perfectly possible to do the two under the same shareholding, but I don’t believe that it should be done within the same corporate entity. I feel that if we look across the whole scene, that very few have succeeded in integrating the two businesses satisfactorily.

And if you consider that the sorts of commercial banks we’re talking to have probably enjoyed, if that’s the right word, an implicit guarantee from the jurisdiction in which they’re working, then I think that proprietary trading does not sit well with the concept of an implicit guarantee from the government.

ED: A number of banks also get into the trouble of mixing proprietary trading with what they do for their clients. What do you think is happening on that front today?

GM: As a matter of fact in the marketplace, the level of activity is reduced. The buyout business—private equity—is at a low point at the moment, but it will come back again, so I do feel that people are waiting to see what the result of the review of what’s been going on in banking over the last few years will be, and whether there will be governments insisting on separation of proprietary trading and commercial banking.

ED: And so what do you think the regulators should be doing at this point?

GM: I think the regulators should separate investment banking/ proprietary trading from commercial banking. It doesn’t mean to say that it cannot be done under the same ownership, but they should separate them. The investment banking side should be in a separate subsidiary, separately capitalised and should have the capacity of failure if that is what it leads to.

ED: And what is your take on what’s happening in the US today where the investment banks are being reconstituted as commercial banks.

GM: I mean, I don’t agree with that, and I’m not sure that that’s the end of the story.

ED: And what do you think the end of the story might be?

GM: Well, I don’t like to prognosticate things like that, but you could effectively see it going back a sort of Glass-Steagall situation.

ED: And in terms of how you think the US investment banks are going to play out in the next few years—in the medium term, what do you think the scenario is going to look like?

GM: I don’t really know, to be honest. Goldman Sachs I think is far too big. I think it poses a systemic risk. I think, as such, it enjoys an implicit guarantee. As such, one has to ask the question: is that level of proprietary trading compatible with that situation?

ED: Given the scenario of how financial services turned out today, what kind of banks do you like? Which banks, when you look at them, do you think are doing the right thing and sort of have the formula in place to be sustainable and to continue growing?

GM: I like Santander. I like the way that they’ve developed internationally in terms of how they tend to favour having minority shareholdings in these countries. They are individually capitalised in these countries, yet they have a strong credit culture, and they are a very good retail bank, and they have resisted the temptation to go into investment banking. So I like Santander.

I also like HSBC, despite the fact that it’s done various things over the years—we all make mistakes, but obviously it’s very well positioned. I think that it’s kind of naïve in a way to think that it is above and beyond all the government [protections], it probably enjoys an implicit guarantee from both the UK and China, but I think it’s in a good place.

ED: The two institutions that you mentioned, they are highly conservative, they are very true to their core business, and in the case of Santander, it’s actually a family run bank, in a sense.

GM: I think that’s oversimplifying it, saying it’s a family run bank. It is true that Emilio Botin is still the strong man at the bank, but he has got exceptionally good executives. The fact that his daughter, Anna, may—and I say may—succeed, does not mean that it’s a family run bank. I think that’s definitely an oversimplification as far as Santander is concerned.

ED: Well, the other thing about these two names that you mention is they act over and above shareholder return as an immediate goal. They’re conservative. They almost make shareholder return a secondary goal to maintaining their franchise.

GM: Well, I wonder if Santander really is conservative. I mean, this is a bank that took positions in South America, which very few other banks would do, and has in fact built up a competitive advantage in its understanding of South America. It is thought of as being conservative, because it is fundamentally a retail and commercial bank. But I would not honestly think of it as being a conservative bank. They think about new things and they do new things. I was very close to them for several years when we had our collaboration between RBS and Santander.

ED: Santander and HSBC are out there on the radar screens and they’re very visible …

GM: Uh huh, everybody knows, yeah.

ED: Are there institutions coming online which you think are doing the right things today that would probably bea Santander of the future in Europe today?

GM: I cannot honestly say that there are, no. I cannot see that there are.

ED: Give us a sense of what you think the UK is going to look like in the next three to five years, given the current government and the current priorities that the government has put in place.

GM: Well, I think we’re really in a position where that’s very difficult to say because the Banking Commission will be publishing its report over the next few months. We could see radical changes being made in the UK banks, particularly with Lloyds [Banking Group]. It’s conceivable that Lloyds could be broken up; certainly, the transaction between Lloyds and HBOS was wrongly conceived, and—standing back from it—it probably should be reversed. Whether it’s pragmatic or practical to do, that is a different issue. The results of this, nobody really knows at the moment. There’s a lot of uncertainty there.

ED: The Lloyds/HBOS deal was wrongly conceived because of the size of the deal…?

GM: It was wrongly conceived for all sorts of reasons. Firstly, it was a deal done in haste; it was a deal done after the mortgage issues had emerged, and yet went ahead; it was a deal done with a political dimension; and it was a deal done as a way of avoiding the competition commission. Lloyds had for years been trying to do a transaction, but had always been stopped because of competition. And correctly so—they have a very large share of the retail market. This was a way of getting round that. It suited the government of the day. It was just wrongly conceived.

ED: And what do you think should be the checks and balances put in place going forward to avoid something like this?

GM: Well, I think the checks and balances were there. They were just avoided. I think that the government felt that it could, by doing this, avoid the problem of HBOS; but of course that just transferred the problem to Lloyds, and I feel it was a government decision really.

ED: A government that is quite determined to keep its budget in place and not take on any more risks than it needs to—what’s the implication for banking in the UK today?

GM: Well, I mean, I think that if you look at the issues in the Lloyds/HBOS, the government did not want to take on the responsibility of HBOS. And they felt that by passing it on, or making it possible for it to be passed on to Lloyds, that would avoid them doing so; of course, it didn’t, it ended up on the balance sheet anyway. Effectively, it’s always on the balance sheet, because it is too big a retail bank to fail in the sense of not meeting its depositors’ expectations. Therefore, I think that was a wrong decision.

ED: So do you think that the UK government should be throwing more money at the financial sector until it sort of finds its feet?

GM: I don’t think they should be throwing more money at it, no. I do think that you have to face reality, and the reality is that these big banks cannot be allowed to fail in the sense of not meeting the depositors’ expectations. I think the reality is that they are guaranteed by the government.

ED: This whole theme of being guaranteed by government—to what extent should governments go out on a limb to provide implicit guarantees? Or should they just say that there are institutions that are guaranteed and…

GM: I think they should say it. I mean, I think if we had an institution of a size that its failure would pose a systemic risk to society that was unacceptable, then like it or not, it is guaranteed by the government. And to say it is just to admit to what the facts are, and not to say it is just the same as Enron. It’s on your balance sheet in reality. So I think they should say it. Now, it has implications. It would also mean that the regulators would pay a little more attention, I feel, to it, if they knew that it was actually on the national balance sheet.

ED: What is your sense of the FSA being subsumed back into the Bank of England? Is that a good move?

GM: You shuffle the cards. What is the reality? The same people are there, more or less. The Bank of England did not have responsibility before, they now have the responsibility. But the Bank of England were there! What were they doing!? Did they not pick up the phone and say to the FSA, “Hey, is there not a big systemic risk here?” Or vice versa? So I don’t see that there’s any excuse for not picking up your responsibilities when they can be clearly seen, and I find the posture of the current governor somewhat questionable in this, where he is being very outspoken and blaming the banks for what happened, but we seem to have forgotten he was there throughout all that time.

ED: But do you think the regulators are facing pressure in the sense that they need to be seen as doing the job that they were supposed to be doing?

GM: Well, I think they should just be doing their job as far as I’m concerned, and they didn’t. It’s their job to keep the country out of systemic risk. That is clearly their number one job, and they failed.

ED: Is their job better done with an independent FSA or do you think the job will continue to be done well with the Bank of England subsuming the responsibility?

GM: I don’t think it makes any difference. I think it depends on the people who are doing it and whether they’re facing up to doing the job.

ED: Final question—looking back on the franchise that you’ve created in RBS and what it became eventually—what is the one thing that you might have done differently?

GM: Well, I’ve given a little thought to this, and one thing’s kind of difficult to choose. All of us as bankers should pay more attention to the macroeconomic issues. I think we do read the macroeconomics, but we don’t necessarily debate it seriously enough and take action on it, particularly when that action involves perhaps going against the wishes of your investors. I think that in looking back, what would I have done differently? I find it difficult—I don’t think I’d have done much differently as a chief executive. As a chairman, I might have been a little more interventionist as a chairman.

ED: And why weren’t you in your time?

GM: I felt that the bank as a whole was extremely successful and that the chairman’s job is to put ideas forward perhaps, but not to execute. That’s a chief executive’s job.

ED: So you would imply that RBS became a victim of its own success, in that way?

GM: I think that certainly RBS was somewhat a victim of its own success. But let us not run away from another essential truth: every large bank in the world, practically, became a victim of its own success. And all of these chief executives throughout the world were very able people, and I think that they’re probably also very committed and well-motivated people. But we can just go through the names and the places.

ED: And so what’s the antidote to that? How does a CEO ensure that they don’t believe their own hubris?

GM: I think perhaps just by reading history, and being very conscious that you’re just another person, like anybody else.